By ROBERT HARLEY 27/08/2010
Stock markets found a floor in early July as investor concerns over euro sovereign debt abated and buyers moved in to take advantage of the cheaper prices on offer. The publication of the European Union banking sector stress tests in late July provided a further catalyst to re-invigorate markets. Whilst the credibility of these tests might be questionable, the provision of additional transparency on bank balance sheets was welcomed by investors. Meanwhile the most recent set of US corporate quarterly results continued to display positive momentum; the bulk of companies exceeding earnings expectations and also surprising on revenue growth - albeit to a lesser degree.
However, disturbingly stock market volumes remain very low, suggesting investor sentiment is fragile. Indeed for several weeks US leading indicators had been pointing towards a deterioration in economic activity, consequently it might have come as no surprise that the US Federal Reserve moved to downgrade the growth outlook for the US economy in mid July. The Bank of England followed the US lead by cutting its own growth forecasts in early August, albeit by a more modest figure. These revisions also come against a backdrop of fading Chinese economic growth, as steps taken by the authorities to put the brake on it’s runaway economy start to bite. In stark contrast, the German economy has maintained its momentum, prompting their Finance Ministry to raise growth forecasts for the year.
Income yields on UK gilts, German bunds and US treasuries, resumed their trend down to record lows, suggesting that growth and inflationary expectations are likely to fall further in the forthcoming quarters, an announcement by US Fed in August that it was to resume buying US treasuries also provided support for the market. This has resurrected talk of a bubble in the government bond markets; admittedly at these lower levels, yields are already starting to price in a fairly negative scenario and it is difficult to envisage this rate of decline continuing. However the use of quantitative easing by the US Federal Reserve, with the option to extend this policy, could continue to keep yields suppressed. Bond bears may have to be patient.
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